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Get out your calculator and file folders; it’s that time of year when a little financial planning can go a long way. We asked our friends at MoneySense for their best RRSP advice

The following is an excerpt from the MoneySense Extra! “The Ultimate Guide to RRSPs” available for download now in your app store and on Next Issue.

1. What is an RRSP?

Of course you know what an RRSP is—it’s that thing you’re putting money into to save for retirement, right? Beyond that, many people’s understanding of RRSPs is pretty fuzzy. A common misconception is that the RRSP is a type of investment like a mutual fund, but it’s not. It’s simply a saving or investing account with certain tax-saving characteristics. When your bank sells you an RRSP, all they’re selling you is a prepackaged investment—usually a collection of mutual funds or a wrap program—that happens to be in an RRSP or registered account. But you can also open an empty RRSP account at your bank or discount brokerage and put whatever investments you want in it. You can even hold several different RRSP accounts with different institutions. “It’s really a personal pension plan,” says Peter Volpé, senior vice-president of the Toronto wealth management firm Integra. “For those of us who don’t have a pension plan to fall back on, it’s our best opportunity to build our own pension.”

2. How much can I contribute to my RRSP this year?

Up to 18% of your income to a maximum of $24,270 for the 2014 tax year. For 2015, the maximum will be $24,930. But if you didn’t max out your contributions in previous years (and most people didn’t) you can probably put in much more. Check the notice of assessment form the government sent you after processing last year’s tax return. The amount you can contribute will appear on the form.

3. When is the contribution deadline?

March 2, 2015 is the deadline for contributing to an RRSP for the 2014 tax year.

4. What kind of investments should I hold in my RRSP?

“All the general principles of portfolio-building apply,” says Eric Kirzner, professor of finance at Toronto’s Rotman School of Management. “You still want to have a proper balance of safety, income and growth.”

A good place to start is a portfolio of mutual funds that delivers a 60/40 split between stocks and bonds. Exchange-traded funds (ETFs) that give you the same split are a better bet, as their low fees mean they have a greater potential for growth.

If you have enough money to build both a registered and non-registered portfolio, then investments such as bonds, GICs and high-interest savings accounts are best kept inside of an RRSP, because their interest income is taxed at a higher rate. Capital gains and dividends are taxed at a lower rate, so stocks can go outside your RRSP.

5. Should I change my RRSP investments as I get older?

Yes. As a general rule, the closer you are to retirement, the safer your portfolio should be. When you’re in your 20s, 30s and 40s, it’s fine to have up to 60% of your money in equities, because if the stock market tanks, there’s time to recover. But in your 50s and 60s, one bad year in the market can do serious harm.

One useful rule is to subtract your age from 100 and invest no more than the remainder in stocks. So if you’re 40, you can put 60% of your portfolio in stocks, but if you’re 60, you should have no more than 40% in stocks. There are several life-cycle funds on the market that will automatically do this for you.

Tina Di Vito, director of retirement strategies at BMO, also suggests that as you get closer to retirement you start building up a buffer. How much? Just calculate what annual retirement income you’ll need and multiply it by three. If you think you’ll need to withdraw $20,000 a year, then in the years before you retire, build up a $60,000 buffer in ultra-safe investments, such as money market funds or GICs.

The cover of MoneySense’s special RRSP edition.

6. Is the money in my RRSP really tax-free?

No, the government will get its pound of flesh later. This is how it works: Say you put $5,000 in an RRSP this year. You’ll get a tax deduction on that money, so you effectively are delaying paying income tax. But when you take that money out of the RRSP—whether it’s during retirement, or any other time—you will be taxed on that income just like you’re taxed on any other income you earn.

The way to get the most out of RRSPs is to put money in when you’re in a higher tax bracket—when you’re working full time and earning at least $40,000—and take it out in retirement, when you have less income and you’re in a lower tax bracket. This way you pay less tax in total to the government.

The other main benefit of RRSPs is that investments grow inside the plan tax-free. This means you don’t have to pay capital gains when you sell stocks and you don’t have to pay tax when you receive interest and dividends. When you take money out of your RRSP, it’s taxed as if it was income earned that year.

7. How much should I contribute to my RRSP this year?

There’s no hard and fast rule. The goal for most people is to contribute enough so that when you retire, you can maintain the same lifestyle you enjoyed while you were working.

The maximum you can contribute each year is 18% of your income, and if you’re managing that, you’re good. Each year, roughly two thirds of Canadians contribute nothing at all. We find that contributing about 12% of your pre-tax income each year should be fine for most people, as long as you contribute regularly, invest wisely and don’t take on a massive mortgage or large amounts of other debt.

8. I maxed out my 2014 RRSP contributions. Can I add money to my RRSP in January and February, and count it as 2015 contributions?

Yes, contributions made in the first two months of the year can be declared for either tax year. If you don’t want the contribution included on your 2014 tax return, just wait and include the amount you deposited on your tax return for 2015.

9. Are real estate investment trusts (REITs) a good choice for my RRSP?

Real estate investment trusts (REITs) can be attractive investment options for tax shelters like RRSPs due to their high yields. The Dow Jones Canada Select Equal Weight REIT Index—a consolidation of Canadian REITs—was yielding 5.79% as of January 31, 2015.

When Canadians are building a retirement portfolio, what better benchmark to examine than our very own Canada Pension Plan? The CPP had an 11.6% allocation to real estate as of the year ending March 31, 2014. Given the current low interest rate environment, REITs may be considered by some as an alternative to bonds. The low rates actually help REITs, since they typically use debt to help finance their purchases of residential, commercial and industrial real estate. The strong real estate price backdrop across the country has led to continued stock price appreciation.

Real estate should make up part of a balanced investment portfolio. Balance is the key word, so add REITs to your RRSPs with moderation.

10. Should I invest more conservatively in my RRSP than I would in a non-registered account?

Yes. RRSPs are no place to gamble with Peruvian mining stocks and other risky investments that could ruin your retirement plans. You should aim for a balanced portfolio containing a mix of equities and safer investments such as bonds and GICs.

If you do enjoy taking a gamble on stocks, put them into your non-registered accounts. If the stock turns out to be a dud and you end up selling the shares, you can at least claim a tax deduction on the capital losses. In an RRSP, no such deduction is allowed.

11. I have a pension. Do I need an RRSP too?

For most people the answer is yes—although if you have a good pension at work, you can certainly contribute less to your RRSP than someone without one. With no pension, you can contribute up to 18% of your income to an RRSP each year. If you have a private pension, then the amount you are allowed to contribute to your RRSP will be reduced, to reflect the fact that you are also contributing to your retirement income through your pension at work.

There is one group that doesn’t need RRSPs at all: government workers. Teachers, police officers and other civil servants have among the best pension plans available and won’t need help from RRSPs to retire comfortably. For instance, a couple who are both government workers can expect to enjoy a combined annual pension income of at least $50,000, which is roughly the kind of income that a million-dollar portfolio would generate.

12. What happens to my RRSP when I retire?

You can leave your investments inside your RRSP until you’re 71, regardless of whether you’re working or not. But at age 71, you have to wind up your RRSP and start taking the money out. If you took all the money out at once and claimed it as income, you’d get a massive tax bill that year, so most people transfer their assets into a Registered Retirement Income Fund, or RRIF, so they can convert them into a regular monthly retirement income.

You don’t have to liquidate your investments to convert your RRSP to an RRIF. You just sign a document and change the name of the account. What really changes is the rules: You can’t put any more money in, and you are forced to start taking money out. Your financial institution will send you a notice telling you the minimum amount you need to take out each year. Typically, at age 71 you have to take out around 7%, and that amount gradually increases to 20% by age 94.

Most people decide to change the composition of their investments when they retire, as income and safety are now priorities, rather than growth. This can mean adding an annuity, which guarantees a set monthly payment for a set period of time (often for life). Unfortunately, rates are very low right now, so annuities aren’t a great buy. Other options include bonds, dividend-paying stocks and even income trusts.

13. Which should I contribute to first: my mortgage or my RRSP?

Financial planners have debated it for years, but from a pure dollars-and-cents perspective the correct answer is usually to pay your mortgage down first. Every time you make an extra mortgage payment you reduce the amount owed on the principal. If your mortgage interest rate is 3%, paying it off faster is like getting a guaranteed 3% return. Yes, you can get a better return than that in the stock market (if you’re lucky), but it’s not guaranteed. So unless you can find GICs that pay 3%, you may want to attack the mortgage first.

14. What’s the best way to invest in my RRSP: Should I buy stocks, mutual funds or ETFs?

It all comes down to what kind of investor you are. If you are disciplined, informed and willing to put in the time, you can do very well by buying individual stocks. However, you need to stick to a proven strategy, such as value investing, and you should buy for the long run. Studies show that most stock pickers trade too often, and can get sucked into hot sectors, so they’re always buying high and selling low.

Mutual funds are the most popular way to invest for retirement, and they are a good choice if you’re just starting out. But you should stick to an asset allocation that works for you, and keep your fees low. Go to moneysense.ca/mutualfunds for a list of good bets.

Investing in index funds or exchange-traded funds (ETFs) is a great way to invest for both beginners and the more experienced. Our Couch Potato Portfolio of ETFs can give you many of the benefits of mutual funds at a much lower cost, which means a higher return over the long run. Go to moneysense.ca/bestetfs to start building your ETF portfolio.

15. Should I get a spousal RRSP?

Spousal RRSPs can save couples a lot of money, although they are less important than they used to be. The idea is to equalize the incomes of the spouses as much as possible to reduce your tax bill. It works because you pay far more tax on a single $100,000 income than you do on two $50,000 incomes.

The best way to use them is for the higher earning spouse to contribute to a spousal RRSP in his or her partner’s name. These contributions will use up some of that person’s contribution room, but when the RRSPs are wound up, you’ll have two smaller incomes instead of one big income so you’ll save on taxes. Still, spousal RRSPs are less popular than they used to be. That’s because recent changes allow couples over 65 to split their income from RRIFs, annuities and pensions for tax purposes.

16. Can I take money out of my RRSP without a penalty?

Yes, if you’re using it to buy your first home or head back to school. Under the federal Home Buyers’ Plan, you can withdraw up to $25,000 from RRSPs without paying tax. The catch is you have to repay the full amount within 15 years. You can also withdraw $20,000 from your RRSPs tax-free to finance your education, though no more than $10,000 in one year. Once again, the money has to be repaid.

Outside of those programs, if you try to withdraw money from your RRSP you’ll usually be hit with a steep withholding tax—as much as 30% of the money you withdraw. That penalty will eventually be refunded if your income is low enough though (see below).

17. I’m taking a year off work without pay. Is that a good time to withdraw funds from my RRSP?

When your income is low, you pay less tax on your RRSP withdrawals, so it can be an excellent time to shovel money out—as long as you trust yourself to put it right into a TFSA and continue saving. You’ll initially be hit with a substantial withholding tax, but if your total income for the year—including your RRSP withdrawal—is less that $10,000, when you file your return the tax is refunded.

18. How much should I have in my RRSP for my age?

It depends on how luxurious a retirement you want. To get a rough idea, start by adding up how much annual income you think you’ll need in retirement; then subtract the amount of money you expect to get from your company pension, Canada Pension Plan and Old Age Security. Then multiply that amount by 30. That’s how much you need to have saved by the time you retire, says Jim Otar, founder of RetirementOptimizer.com.

Here’s an example: You and your spouse are together earning $120,000 a year. Most retirees can live comfortably on half their pre-retirement income. That’s $60,000. Many couples in that situation will get about $39,000 a year in retirement income from the Canada Pension Plan and Old Age Security, so you’ll need an additional $21,000 a year from your own savings. Multiply that by 30 and you get close to $630,000. That’s the amount you need to have banked by the time you retire.

How do you know whether you’re on track to reach your goal? The chart above offers some sample numbers, based on a few realistic assumptions. The first is that in the early years of your career, RRSPs won’t be a priority. If you’re in your 20s, you’re probably too busy going to school and getting your career started to contribute. Any extra money you do earn should go towards paying down debts. By your early 30s, the mortgage, cars and kids are weighing you down. It’s okay to skip RRSP contributions during these years too, says retirement expert and actuary Malcolm Hamilton—as long as you don’t make the mistake of overspending and digging yourself deep into debt.

Once you’re in your mid-30s, it’s time to start attacking those RRSPs. To reach the $630,000 goal, you and your spouse would have to start putting a combined $7,000 a year into your RRSPs at age 35. These calculations are based on a 5% annual return and yearly contributions that rise 2% annually to keep pace with inflation. Don’t fret if this timetable sounds ambitious. Even if you can’t come up with $7,000 every year in your 30s, you’ll probably be able to catch up in your 50s with larger contributions. By then, your mortgage should be paid off and the kids finished university. That’s when you need to get really serious about putting money into RRSPs if you want to make that $630,000 target.

19. Should I use an RRSP or a TFSA?

Confused by another set of letters? Don’t be. TFSAs, or Tax-Free Savings Accounts, are simply one more way to shelter your money from the taxman. The difference is that with RRSPs, you get a tax break when you contribute. When the money’s withdrawn, you’re taxed. For TFSAs, the process reverses. There’s no tax break up front, but the government can’t get its paws on your money when the funds are withdrawn.

So which is better? It all depends on how much money you make. Canadians earning less than $36,000 should use TFSAs, says Gordon Pape, author of The Ultimate TFSA Guide. The reason is that people with lower incomes can make more in retirement than they do when they are working, due to the government benefits you get at age 65. You always want to pay income taxes when your income is lower, so if you make less than $36,000 it’s better if the money is taxed before you put it in your retirement savings, as is the case with a TFSA. Plus, when you retire, the money you take from TFSAs isn’t considered income, so it won’t result in clawbacks to Old Age Security and the Guaranteed Income Supplement. The same isn’t true for RRSPs.

If you’re just starting your career and earning in the $30,000 range, you could start with TFSAs and when your income goes up, you could switch to RRSPs. Not only will you get larger tax breaks, but you’ll have built up lots of extra RRSP contribution room from the years you were using a TFSA instead.

20. What is the most tax-efficient way to get money out of RRSPs?

If you thought saving up for your retirement was tricky, wait until you quit working and start spending some of that money.

The trouble often starts when people turn 65. If they have a good pension and other investments to draw from, they don’t dip into their RRSPs at all at first. But when they turn 71, the government forces them to start withdrawals, and because their income is so high, more than 40% of that money could go to the taxman.

One way to avoid this problem is to look at ways to keep your income from ballooning when you hit 71. If you’re not going to need much money from RRSPs until your 70s, you may want to consider retiring earlier than you planned and taking money out of your RRSPs early so it’ll get taxed at a lower rate.

You can also try a few tax-saving manoeuvres. For instance, in the years just before you retire, don’t claim the tax deduction on your RRSP contributions. You can defer those deductions to later years when your income is higher and you really need them, says Tim Cestnick, author of 101 Tax Secrets for Canadians.

Another option is to buy flow-through shares issued by certain mining and oil exploration companies. The tax credit you get from investing in these firms can be high enough to offset the taxes you have to pay on RRSP withdrawals.

For more from the MoneySense Extra! “The Ultimate Guide to RRSPs” download the MoneySense App or find MoneySense on Next Issue.

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